Illustration: Binay Sinha
In the heart of Gurgaon’s glittering Cyber City, Arun Singh stares at his computer screen, his finger hovering over the ‘send’ button. Your company has given you a bonus and you are faced with a dilemma: should you use the money to pay off your home loan early or make investments?
Click here to connect with us on WhatsApp
The decision to pay off a mortgage loan early or invest in financial instruments is a dilemma many homeowners face. The choice depends on several factors, including interest rates, potential investment returns, tax benefits, and financial goals.
Key points to consider: prepayment of a mortgage loan versus investment
Interest rate comparison:
Compare the interest rate on your home loan with the potential investment returns.
Tax implications:
Compare the tax deductions available on mortgage loan interest with the tax implications on returns
Risk tolerance:
Prepaying a loan offers guaranteed returns in the form of interest savings.
Investments, especially in stocks, carry market risks but have the potential to generate higher returns.
Financial goals:
Align your decision with short- and long-term financial goals.
Consider whether it is more important for you to become debt-free sooner or to build a larger investment corpus.
Job security and income stability:
In times of economic uncertainty, reducing debt could provide more peace of mind.
A stable income could allow for greater risk-taking in investments.
Age and life stage:
Younger people could benefit more from long-term investments.
Those nearing retirement might prefer the security of a reduced or paid off home loan.
Emotional factors:
Some people sleep better knowing they are reducing their debt burden.
Others might feel more financially empowered by growing their investment portfolio.
Remaining duration of loan:
Prepayment in the early years of a loan saves more interest than in later years.
Consider the impact on the life of your loan if you make partial prepayments.
Emergency fund:
Make sure you have adequate emergency savings before considering down payments or investments.
Future credit needs:
Keeping a loan account in good standing can be beneficial for future credit requirements.
Completely closing a loan could affect your credit mix and score.
“Whether you should pay off your home loan or invest will depend on a few factors. The biggest among them is the return you expect to earn on your investments (and therefore your choice of investment instruments) versus the interest rate charged on your home loan,” said Gaurav Arora, fund manager at Equirus.
“If you are a prime customer whose home loan interest rate is between 8 and 10 percent, it makes financial sense to invest that money in stocks and related instruments for the long term. Since home loans are a long-duration product , would fit with the long-term nature of the investment required for stocks.”
“The benefit of tax savings on payment and proposal becomes even better. However, if the home loan interest rate is 10, as lower-quality customers are charged, it is probably better to pay off the high-cost home loan first. Another nuance that many do not appreciate is that many people who make money through real estate do so because of the high but relatively safe leverage inherent in real estate purchases. Prepaying the loan would nullify that entire premise,” he said.
“Over a typical home loan duration of 20 years, even investing in index funds instead of paying upfront could result in a significantly larger corpus due to compounding and the spread between index fund returns and net borrowing costs. . However, if your future cash flows are uncertain or limited, prepayment might be prudent,” said Priyank Shah, co-founder and CEO of The Financialist, a financial advisory firm.
First published: September 27, 2024 | 11:19 am IS
Disclaimer:
The information contained in this post is for general information purposes only. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the website or the information, products, services, or related graphics contained on the post for any purpose.
We respect the intellectual property rights of content creators. If you are the owner of any material featured on our website and have concerns about its use, please contact us. We are committed to addressing any copyright issues promptly and will remove any material within 2 days of receiving a request from the rightful owner.